Saturday, October 17, 2009

A friend brings to my attention an otherwise-interesting post by Kevin Drum discussing the recent Social Security COLA imbroglio. Drum makes the interesting point that annual COLAs give the impression of rising benefits even when the real buying power of benefits stays the same. (Economists call this "money illusion" and it's the source of a number of problems.)

But Drum takes things a bit far. He says that

Technical arguments about CPI calculations aside, the fact is that seniors haven't gotten a benefit increase for decades. It's just not the way the program works. But the fact that their checks keep going up makes it seem like they have.

Now, it's true that for current beneficiaries benefits haven't gone up, unless one pays attention to technical arguments regarding whether the current CPI overstates the rate of inflation. (Of course, if you do pay attention to those technical arguments, then – at least according to Northwester economist professor Robert Gordon – it's possible the that real value of benefits has been rising by 1 percent or more above the rate of inflation.)

But that ignores another point: the real value of benefits for new retirees has been rising consistently. That is, a new retiree this year doesn't get the same benefits as a new retiree last year; rather, he or she receives higher benefits. (Or at least they should; if I'm right about the new Social Security "notch" then they actually get lower benefits, but that's another story…). The chart below shows the real benefit level for new, medium wage retirees in years from 1998 through 2018.

As you can see, benefits increase pretty significantly: a new retiree in 2018 receive benefits around 29 percent higher in real terms than a new retiree in 1998. A prominent reform proposal "price indexing" would arrest this increase: rather than having benefits rise with wages from cohort to cohort, they would rise only with inflation. In effect, price indexing would be an inflation-adjusted freeze on future benefit growth. While this has been proposed, however, it's definitely not what we've seen over the past several decades.

2 comments:

That seems somewhat at odds with the claim that current solvency issues are primarily a product of over-generosity to recipients in the past.

The current formula for adjusting initial benefits to real wage increases over a worker's lifetime suggests that each succeding cohort shares in overall economic progress when measured as a basket of goods even though the income replacement ratio stays relatively level.

In countering Drum's admittedly flawed argument are you not at the same time undercutting the intergenerational inequity argument?

I don't think so; average benefits are rising from cohort-to-cohort, but so are average wages and taxes paid, so the typical future Social Security participant will have paid more than enough taxes to finance his/her own benefits. The fact that this is happening while the system itself will be running large deficits says there's something else going on.

About me

I am a Resident Scholar at the American Enterprise Institute in Washington, where my work focuses on Social Security policy. Previously I held several positions within the Social Security Administration, including Deputy Commissioner for Policy and principal Deputy Commissioner. Prior to that I was a Social Security Analyst at the Cato Institute. In 2005 I worked on Social Security reform at the White House National Economic Council, and in 2001 I was on the staff of the President's Commission to Strengthen Social Security. My Bachelor's degree is from the Queen's University of Belfast, Northern Ireland. I have Master's degrees from Cambridge University and the University of London and a Ph.D. from the London School of Economics and Political Science. I can be contacted at andrew.biggs @ aei.org.